Patents and Innovation Economics

Rand in The Virtue of Selfishness states that a breach of contract is the use of force, like fraud is an indirect use of force.

A unilateral breach of contract involves an indirect use of physical force: it consists, in essence, of one man receiving the material values, goods or services of another, then refusing to pay for them and thus keeping them by force (by mere physical possession), not by right—i.e., keeping them without the consent of the owner. Fraud involves a similarly indirect use of force: it consists of obtaining material values without their owner’s consent, under false pretenses or false promises.

“The Nature of Government,” The Virtue of Selfishness, 111

This is incorrect and to the extent Objectivists accept this they hurt themselves and their psyche. A simple example will illustrate the flaw in the above statement. Assume a musician contracts to play at a venue a month from now. Then the day before the concert he is killed in a car accident. The musician certainly cannot fulfill the contract, so he is in breach of the contract and it was unilateral. The venue and promoter will certainly lose money because of this. Should the promoter be able to sue for breach of contract and recover damages?

A contract is a legally enforceable promise. In any immediate contract, such as buying food, contract law is boils down to fraud protection. It ensures that the purchaser does not take the goods and not pay for them or that the merchant does not take the money and not hand over the goods. For immediate contracts Rand’s statement above is true.

Long term contracts that are carried out over several days to several years can easily have extenuating circumstances that mean a breach is not an indirect use of force. Remember a contract is a legally enforceable promise. This promise cannot take every circumstance into account. One way lawyers try to account for unforeseeable circumstances in a contract is by inserting an “act of god clause”, also known as a force majeure clause. When these clauses are used in insurance contracts they lead to a contradiction. The whole purpose of insurance is to protect against unforeseen events. They are bad clauses in any contract because they are inherently vague and subject to widely varying interpretations.

When a contract is in dispute the role of the court is to discern what the parties intended. If the parties did not take something into account, such as the musician dying in a car accident, then the court has to decide what the parties would have done if they had thought about the issue. In the case of the musician, the “breach” was not intentional. I doubt that the intention of the parties was to hold the musician financially responsible if he dies in a car accident the day before the concert. Lawyers can try to anticipate every circumstance but this leads to long unread contracts, where the parties really did not agree to obscure clauses. It also leads to what is called the battle of the forms, where each party tries to get the other party to agree to their form just as the deal is closed. Clauses that are not discussed or agreed to explicitly defeat the real intention of contracts and should be viewed with skepticism by courts.

Government imposed clauses, such as the Uniform Commercial Codes’ (UCC) implied warranty of merchantability should never be allowed. The implied warrant of merchantability “is a warranty implied by law that if a seller knows or has reason to know of a particular purpose for which some item is being purchased by the buyer, the seller is guaranteeing that the item is fit for that particular purpose.”[1] There is no need for the implied warrant of merchantability if that was intended by the parties and if it was not the intention then it should not be enforceable. This “implied warranty of merchantability is why software was licensed and not sold. Software could not meet the implied warrant to merchantability in its early days. This lead to a number of other problems that still afflict us in the software space and is an example of the unintended problems that occur when the law is stretch outside of its logical framework.[2] Note that a contract to commit a tort (crime) is not and should not be enforceable.

Long term contracts, such as thirty of even forty year mortgages, are fraught with unforeseeable circumstances. We cannot know the future that well. In cases like these even intentional breaches are not necessarily the use of indirect force. Many long term contracts have termination clauses to account for this and to an extent invoking the termination clause is not a breach. However, most termination clauses have a part that covers a breach and how it is handled. For instance, a long term contract to supply say gas to a business on the first of the month, might be breached if the supplier’s truck(s) is broken down on the first of the month. Technically the supplier is in breach of the contract. Most termination clauses will allow the breaching party to cure the breach within a period of time.

What if the supplier’s wife is murder and he becomes depressed and chooses not to deliver gas anymore. The supplier is intentionally breaching the contract, but has he used indirect force against the customer? Most likely the customer has not paid for the gas yet or has only paid for one month in advance. A contract cannot be used to turn someone into a slave. Because of this, all long term contracts have an implied termination clause. It is also why we have bankruptcy laws. It is also important to note that you do not have right to a risk free life and law cannot and should not be used to remedy every small harm that happens to people.

Mortgages are an interesting long term contract and of course in the news after the financial crisis in the U.S. in 2008. People have the mistaken impression that a mortgage is like a personal loan between friends. The bank does not give the house buyer money out of its coffers, it creates the money. The bank collateralizes the house, much like a bond issuer creates the bonds “out of thin air”. The bank takes legal title to the house either directly or indirectly as security that the loan will be paid back. If the “home owner” cannot or does not pay the mortgage the bank asserts its legal ownership of the house and sells the house to extinguish the money created in the mortgage contract. Note I did not say pay back the mortgage. The money is literally destroyed, just like a bond that has been paid off no longer exists. If the home owner purposely breaches the mortgage, did they use indirect force? One answer is no because the mortgage contract implicitly includes a termination clause that the bank takes legal control of the house if the mortgage is not paid. In other words the bank made a deal that if you payoff the mortgage you get legal control of the house and if not the bank gets or keeps legal control of the house.

So how should we think about long term contracts? First of all we should understand that all long term contracts have an implied termination clause. Second, we need to remember that contracts cannot be used to turn people into slaves. Third, we should remember that contracts are an agreement between two parties. As long as the parties are getting along there is no reason for the government to be involved even if the parties are not following the contract. The main reason for most long term contracts is to provide a roadmap of how the two parties are going to do business together. As a result, courts should be skeptical of clauses in contracts that were not discussed. Not doing so turns contracts into a lawyers game of gotcha and does not fulfill the purpose of contracts. Most long term contracts are used by the parties to show their intention at the time the deal was made. This usually comes up when one of the parties is unhappy. A good contract should help resolve these issues. In fact, that is the most important purpose of a long term contract. However, sometimes the issues between the two parties are too great to be resolved. In that case the termination clause, whether implicit or explicit, should kick in. If the termination is too burdensome then bankruptcy laws should kick in. Both parties should be aware of this possibility.

Except for immediate contracts Rand’s statement that unilateral breach of a contract is an indirect use of force is incorrect. This just proves that Rand was human and not an expert in law.

Libertarians make the mistake of trying to base property law on contracts, when it is the other way around. Contract law presumes that both parties own themselves (have legal control over their actions) and often presumes that one or both of the parties have property rights in something. But libertarians like Rothbard try to turn things around and create property rights out of contracts.[3] Reversing cause and effect leads to all sorts of problems. However this mistake by libertarians is based in the fact that they do not understand property rights. In fact, libertarians do not “believe” in property RIGHTS they believe in property privileges that solve the economic problem of scarcity.

A proper understanding of property rights and contracts is essential for a free society to exist. Contracts presume property rights and ownership of one’s self. Long term contracts cannot be used to turn people into slaves or to commit a tort. Objectivists hurt themselves when they treat contracts like Christians treat the Ten Commandments.